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Removing Oligarchs from Per-Capita GDP

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A couple weeks ago, a series of debates, spurred by Paul Krugman, centered on the dynamism of the transatlantic economy. The ensuingback and forth between bloggers and economists over the differences in the European and American economic models highlights the questionable use of aggregate indicators as a measure of the standard of living.

On the other hand, an alternative measure of prosperity is equally elusive. For example, Krugman's use of anecdotes to illustrate the dynamism of Europe’s economies weakens his overall argument:

Europe’s economic success should be obvious even without statistics. For those Americans who have visited Paris: did it look poor and backward? What about Frankfurt or London? You should always bear in mind that when the question is which to believe — official economic statistics or your own lying eyes — the eyes have it.

Paris, Frankfurt and London are not representative of their larger countries. A romantic holiday to central Paris tells little about the overall prosperity of France. The same is true for Frankfurt and London.

Krugman’s critics, such as Tino Sanandaji, quickly pointed out this weakness, arguing that facts are more important than anecdotes. Their solution? Use per-capita GDP figures to calculate prosperity:

Let us compare the latest publicly available per capita GDP of 18 western Europeans countries and the US. We see that the US per capita GDP is $45.500, compared to $33.500 for EU15. Each American produces 36% more than each member of the EU15

If per-capita GDP is used as a measure of comparison, much of Western Europe matches up to America's poorest states. France is slightly poorer than Arkansas; Spain and Italy barely edge out West Virginia and Mississippi, the poorest states in the Union. Washington, DC has a staggering per-capita GDP of $148,046, double that of Europe's richest nation per-capita, Luxembourg.

Yet, this comparison seems equally deceptive. Washington is not twice as prosperous as Luxembourg. Likewise, the differences between Italy and Mississippi are manifest.

So why does any of this matter? And why would anyone working in development care about which rich country is richer?

In fact, the debate over wealth in Europe and America has useful implications for the role of per-capita GDP and inequality in evaluating development successes.

As Joseph Stiglitz and Nicolas Sarkozy frequently point out, indicators such as per-capita GDP are an imperfect proxy measure of welfare. Per-capita income estimates must be supplemented by other variables reflecting the impact of education, environment, health care etc. Above all, per-capita GDP measures say nothing about inequality and who actually controls the lion's share of national wealth.

Decomposing the per-capita GDP according to income shares offers useful insights, providing a more mitigate picture of general trends noticed among high-income countries and developing economies.

A valuable endeavor is to isolate the top income share of 1%.

T.Piketty, and F Alvaredo advanced an interesting cross-country analysis of top income shares time series over more than 20 years. The authors focus on the wealthiest percentile:

From the point of view of income as command over people, is it absolute or relative income that matters? Is it the absolute or the relative number of the rich? One way to answer these questions is based on the capability of the rich to insulate themselves and opt out of communal provision. The separation of the elites, whose members demand private provision of education, health care, gated communities and police services, is a standard feature in Latin America.

From a global perspective, the relevant issue is to know which the quantitative significance of the rich on a world scale is. Does it matter if the share of top 1% in the US doubles? Rough estimates show that in 1992 there were 7.4 million individuals with incomes above 20 times the mean world income ($100,000). More than a third of them were in the US. They constituted 0.14% of the world population and received 5.4% of total world income. Thus, the marked increase in income concentration observed in the US during the last years translated into a perceptible difference to the world distribution.

We've constructed a back-of-the-envelope graphical comparison of national GDP, using the 1% figures from Piketty et al.

First, let's look at Europe and America:

The US has the largest gap between its top earners and everyone else. The Netherlands actually surpasses the US for GDP per-capita of the bottom 99%, and the difference between Germany and the US narrows considerably.

Similar differences in disparity exist among developing countries:

Unfortunately, Piketty, Atkinson and Saez's data on the top 1% of earners in developing countries is limited to a few countries. Nevertheless, the differences between Brazil and Argentina, on one hand, and India and China on the other, are distinct.

What happens if we stretch the top income share out even further? The CIA has calculated the consumption share of the top 10% of households. Converting the consumption share to GDP allows for a wider comparison of developing countries:

Breaking down per capita GDP into income shares allows us to investigate growth and income distribution on the basis of values that provide a more accurate picture when dealing with standards-of-living comparisons (and are reflective of inequalities).

Our charts cloud the interpretation of national growth statistics. Five percent growth in Brazil, South Africa and Chile has very different implications for the vast majority of the population than in Egypt, Pakistan and Ukraine.

Significant statistical distortions can be avoided by isolating the top percentile (or even the top ten). Donor countries would then be able to provide targeted and need-based funding, ultimately optimizing aid mechanisms.

Editor's Note: This post was co-written by Maximilian Hagemes, who is currently interning as Assistant to the Director of the European Council on Foreign Relations in Paris .

Thank you for your comment. The Netherlands does in fact pass the United States when the top 1 percent is removed. Norway remains far ahead, with a per-capita GDP of $50,000, as compared to the Netherlands' $39,000.

Having lived in Western Europe for 20 of the last 30 years, and at the same time traveled through much of the U.S., particularly the South and Midwest, I can tell you the "eyes" have it. The visual decline in many U.S. towns and medium size cities is startling, with half vacant shopping malls, closed factories, and terrible roads (the highways in the U.S. are literally falling apart). For the average person, life is not perfect in Europe, but is significantly better and the opportunity for middle class young people is certainly better, although the working class seems to have been written off on both sides of the Atlantic to live on an underground economy based on the consumption and use of illegal drugs.